Brown Advisory Finding Better Yields in Dividends than Bonds

By Michael Aneiro

Michael Foss manages the Brown Advisory Equity Income Fund (BADAX), which operates under a strategy seeking total return from equity with a significant component coming from dividends.

“We want to balance yield, high-quality companies and some dividend growth,” Foss says. “We don’t overweight any one of those elements versus the others.”

Foss says the fund came about when Brown Advisory realized it was increasingly finding equity yields – including companies like 3M Co. (MMM), Johnson & Johnson (JNJ) and Merck (MRK) – that often exceeded the same companies’ bond yields. At the same time, whenever a bond matured in clients’ bond portfolios there were very few decent options for investing in new bonds. Foss says any stock the fund buys must yield at least as much as the S&P 500, and up to 20% of the fund can be allocated to non-common stock, such as convertibles, preferreds, or even bonds.

The fund’s largest single holding is in gas pipeline company Kinder Morgan (KMI). “They’ve been growing their earnings and payout by about 12% per year and they’re about to close the deal to buy El Paso that will greatly enhance their size,” Foss says. “We have a lot of confidence in the management of the company to give us a nice yield and to grow that yield in the low double digits.”

The fund’s largest sector weighting is in consumer staples companies, which Foss says offer reasonable growth, high quality and very strong balance sheets. He also like healthcare and specialty drug stocks, particularly since they’re somewhat out of favor right now.

On the flip side, he doesn’t like information technology companies. “It’s really s a struggle to find yield in the information technology sector,” he says. “Where you do find some yield there you have to be careful about the quality of the business.”

He says investors are concerned about election-year uncertainty regarding dividend taxation, but that any policy changes are too hard to predict and could end up being a wash anyway.

“The short answer is that none of us really know how that is going to play out,” he says. “But the other side of that coin is that there’s still a big push to reduce the corporate tax rates, and if you’re cutting corporate taxes at the same time as you’re raising the dividend tax, the result is going to be about the same.”